3M (MMM) 2008 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the 3M fourth quarter 2008 earnings conference call.

During the presentation all participants will be in a listen-only mode.

Afterwards you will be invited to participate in the question-and-answer session.

(Operator Instructions) And questions will be taken in the order they are received.

(Operator Instructions) As a reminder this conference is being recorded, thus, January 29th, 2009.

We would now like to turn the call over to 3M.

Good morning, this is Matt Ginter, Head of Investor Relations for 3M, and thanks for joining us today.

As we have been doing the last several quarters both our CEO, George Buckley, and our CFO, Pat Campbell, will be addressing you today and of course we'll have plenty of time for your questions.

Before we begin please take a moment to read the Safe Harbor statement on slide two.

During today's conference call we will make certain predictive statements that reflect our current views and estimates about our future performance and financial results.

These statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties.

Item 1A of our most recent forms 10K and 10-Q, lists some of the important risk factors that could cause actual results to differ from our predictions.

So with that let's begin by turning to slide number three and I will turn the program over to George.

Thank you very much, Matt, and good morning, everybody.

The most important contribution I think that we can make this morning is to give you some understanding of what we see happening out there in the market.

I think it's important to tell you to the best of our knowledge and belief what we think might come next.

Our explanation will tell you how we're thinking about the business conditions and how we are managing the company through the tempest.

Pat will of course detail the quarter and year for you and I will return with our outlook and more specifics about what we're doing to combat the effects of the market downturn, which almost every company in the world sees today.

First, let us speak about the big picture.

Ordinarily, the world's economies are partially out of phase and some are even out of synchronism.

In normal times we might see Germany's economy growing while the US economy shrinking or perhaps Japan is contracting while the US economy is expanding.

The fourth quarter, however, was different from any pattern we've ever seen before, that is the near synchronization of the world's economy in simultaneous contraction.

We did have one reporting segment with positive organic sales growth in quarter four and that was our health care business and safety and security was relatively close.

During times like these it's great to have businesses like this in our portfolio.

The most rapid slow-downs that we saw were in the consumer electronics business, supply components and consumer with the phones and TVs and computers, all located in Asia.

You've all seen what has been happening to suppliers and OEMs in that market.

Automotive and telecoms also continue to weaken as did residential housing.

Overall we saw all of the classic signs one would expect at times like these, cancelled orders, [big] inventory corrections in the channel, long factory shutdowns, many extending well into January, layoffs and overall weak conditions.

While weak business conditions, poor consumer confidence and the psychological fear factor made it worse we believe the principal cause of the downtown was the shortage of credit to lubricate the wheels of global commerce.

That fact effectively locked the cycles of the world's major economies into synchronism and into shrinking mode.

Under such conditions 3M's geographic market diversity is less helpful than normal, though diversity of end markets still does.

Obviously not all of our end markets are shrinking at the same rate and not all had the same cyclic periodicity.

In fact a few, our health information systems, aerospace and security services, for example, are still growing.

There are always three principal effects that one sees at times like these.

The first is that the rate of contraction in sales at wholesale is always a multiple of the rate of contraction in point of sale or retail.

This happens as the channel tries to drain the excess inventory off as fast as possible which it needs to do at a rate higher than its own point of sale shrinkage.

This phenomenon is particularly acute in short-cycle, high turn businesses, such as electronics or retail.

In fast turning short cycle businesses, one would expect the contraction ratio I mentioned just now to be higher than in a slow turning longer cycle business.

At 3M this wholesale to point of sale contraction ratio for the consolidated company is about three with some individual end markets being higher or lower as the case may be.

So the trick here is not to be deceived by a fall in wholesale sales of, say, 15%, because the end market would likely have dropped by a much smaller number, say 5% to 7%.

That is the number that should be reached after all of the sales transients settle down.

In 100% division channel flushing out the excess inventory would take about one inventory cycle to complete; that is one turn or so.

As a practical matter most channels would be a little less efficient than that and the full correction would take a little longer to happen.

The second factor that one nearly always sees in these cases is an overshoot in inventory, as sales fall faster than the cuts in a company's manufacturing rates.

It is because the sales data which a short cycle company receives is always later than the necessary corrective line rate actions it has to take.

It is especially true in a company with long supply chains like ours where we have two-thirds of our sales internationally and two-thirds of our manufacturing in the United States.

The consequence is an overshoot of inventory, albeit a temporary one.

This is not a fundamental problem, just the nature of the beast in the short cycle long supply chain company.

We're already all over that topic.

We see [what was] another thing to watch as the channel tries to conserve cash and push out its own payable stream.

We saw all of these factors work in the fourth quarter at 3M.

As inventory corrections are made the third factor that appears is reduced factory absorption.

Gross margins fall until the factory cost, end market demand and line rates all come into balance.

We expect to see some of this [latter] factory work in the first and second quarters as we drive down inventory.

But we should remember that when the economy recovers we'll see the other and more positive side of this factory absorption curves as pipelines fill correspondingly faster than the point of sale growth.

The principal questions, of course, are how long and how deep the recession will be.

And more importantly what actions 3M is taking not only to combat current conditions, but to emerge an even stronger company.

I'll address the first point in a few minutes when I discuss our outlook.

As to what 3M is doing, we've worked very hard to get ahead of the recession.

We actually began restructuring the second quarter last year as we saw the slow-down coming.

In the fourth quarter alone we reduced over 2,400 full-time positions worldwide, slightly higher than the number we shared with you in December.

These job eliminations span all sectors and geographies, but were particularly focused on those developed economies experiencing more sales pressure.

In addition we've furloughed over 1,000 factory workers until production volumes return to more normal levels.

Contract workers are also being reduced to only those considered essential.

At a minimum these actions in total will save the company $235 million in 2009.

Last October the leadership team at 3M decided to defer merit pay increases in 2009, except in those cases where local laws prohibit it.

That will save us over $100 million annually, also amending our policy on [bank] vacation effectively phasing it out, which will also save the company over $100 million in each of the next two years.

In a tight economy cash is always king.

For 2009 we've already cut capital spending plans by about $0.5 billion, a cut of more than 30%.

A substantial amount of the remaining spending is simply carryover from 2008, or for [tooling] needed for new products and continued operations.

All expense spending is currently on a need to do only basis.

Also to preserve cash we halted stock repurchases until the market offers more visibility and we are declining to offer extended credit terms to drive sales.

You can be assured that we will continue to run the business prudently as conditions dictate.

Well, that is a quick summary of where we're at, so I'll now turn it over to Pat and then return for a discussion of where we will be going.

Pat?

Thanks, George.

And good morning, everyone.

Excuse me.

Please turn to slide number five.

These days it is easy to get caught up in the short term given the current economic and credit market difficulties.

But it is important to remember that we manage our business for long-term success.

Therefore, I will begin to gauge the discussion with a quick review over full-year 2008 results before I cover the fourth quarter.

All information that I will present today will exclude special items which are fully described in the attachment in today's press release.

The strength and consistency of our global portfolio delivered record annual sales of $25.3 billion, or up 3.3% over last year.

Excluding optical systems which most of you know is going through a substantial business transition, sales increased 6.5%.

2008 gross margins declined 70 basis points versus last year, and were flat year on year excluding optical.

This is a good result for the year considering the many challenges we faced, including record high commodity prices and, of course, revenue volume declines in Q4.

Full-year operating income was $5.5 billion, about flat versus last year or up a solid 9.2% excluding optical.

Our 2008 tax rate for the year was just under 31%, down almost a full point from 2007, and in line with our full-year expectations.

We have in fact reduced our tax rate for four consecutive years from 32.5% in 2004, to now just below 31%, and there is more room to improve.

Per share earnings for 2008 were $5.17, up 3.8% year on year, or up over 14% excluding optical.

Overall 2008 was a very good but challenging year for 3M.

We had many successes throughout the year, but we also were negatively impacted by the secular transition of our opticals film business and the rapid economic decline later in the year.

Let us now turn our attention to the fourth quarter results.

Please turn to slide number six.

Fourth quarter sales were $5.5 billion, down 11.2% versus last year or down 8% excluding optical.

Gross margins were lower by 1.8%, with 1.1 points of the decline attributed to optical.

Lower capacity utilization was also a major factor as we adjusted production schedules in response to declining command.

SG&A costs declined $92 million year on year, or 7.3%, as we aggressively reduced G&A costs in the fourth quarter.

Given the rapid decline in sales during the quarter, we also pared back sales and marketing costs in certain businesses.

We invested $337 million in R&D in the quarter or 6.1% to sales.

This ratio was a little higher than last year's fourth quarter, although in absolute dollar terms we did take costs down by 5.6%.

Our long-term commitment to R&D is unchanged, but in this economic environment we're closely scrutinizing all discretionary investments including the labs.

Fourth quarter operating margins were 17.7%, down about three points versus the prior year or down 1.3% excluding optical.

You may have noticed in the attachments in today's press release the corporate non-allocated head operating income of $34 million in the fourth quarter.

As has been the case throughout 2008, the majority of this gain is due to lower year on year pension expense of $29 million.

Rather than allocate this benefit back to our businesses we elected to record this expense reduction in corporate and non-allocated as this number has a tendency to swing on an annual basis.

Net interest expense was $28 million down $5 million year on year, largely due to lower interest rates.

Also recall that in last year's fourth quarter we booked an $8 million loss related to an impaired auction rate security.

There were no such adjustments in the current quarter.

Finally as I previously mentioned per share earnings declined 18.5% to $0.97.

Please turn to slide number seven for a breakdown of our quarterly sales change.

Worldwide sales declined 11.2%, five points of which was due to currency.

Sales in local currencies declined 6%, about equally shared between the US and international.

Organic volumes declined 11%, which was in line with our guidance on December 8th.

A bright spot in the quarter was net selling prices which rose 1.7% our best performance in many years.

Finally acquisitions added just over three points to overall growth in the quarter.

The economy was certainly tough on many of our industrial-based businesses, but there were a couple of bright spots in the portfolio.

Health care, for example, delivered a strong 4.5% local currency growth, and safety, security and protection services delivered over 13%, driven by the 2008 acquisition of Aearo Technologies.

I will talk more about sales in the business segments later.

Fourth quarter US sales declined 6%.

Again we saw a standing growth in safety security and protection and health care.

But overall growth was more than offset by sales declines in our other four segments.

International, local currency sales declined 6.5%, as organic volumes were down 10%, selling prices rose 1% and acquisitions added 2.6 points to growth.

Excluding optical, international local currency sales declined 80 basis points.

Organic volumes were down 6%, which was almost entirely offset by the combination of selling prices and acquisitions which added 2.2 and 3 points to growth respectively.

In local currency terms, sales increased by 9% in Latin America and 3% in Canada, while Europe declined 1.7%.

Local currency sales declined by 17% in Asia-Pacific, 12% of which is due to optical systems.

Please turn to slide eight for a review of the balance sheet and cash flow metrics for the fourth quarter.

Free cash flow for the quarter was $662 million versus $1.3 billion in the fourth quarter of 2007.

Approximately half of the decline is due to lower operating results, with the remainder due to higher international pension contributions, capital expenditures and cash tax payments.

Year end working capital turns were 4.5, a decline of 0.8 turns year on year and 0.5 turns sequentially.

These declines are primarily driven by the rapid slow-down in business activity along with customers drawing down inventories in many industries faster than we could adjust our own production schedules.

Capital expenditures came in at $463 million, up $72 million year on year and $87 million sequentially.

Full year 2008 capital expenditures were $1.471 billion, which was slightly above our plan.

This increase however is related to timing and is offset in our capital expenditure outlook for 2009 which is down greater than 30% as George mentioned to less than $1 billion.

Dividends were up slightly versus last year to $346 million.

Share repurchases were light this quarter at $34 million, reflecting our desire to conserve cash in light of the current economic and credit environments.

We have halted our program until the clouds clear.

Please now turn to slide nine where I will recap the status of our global pension and post-retirement benefit plans.

We all know how tough 2008 was on investors.

Since year end 2007 the funded status of our global pension and post-retirement plans moved from 100% funded to 85%.

Our US plans funded status stood at 89%, with our qualified plan at 92% at year end 2008, and our international plans finished the year at 75%.

I want to commend our pension management team for delivering 2008 US plan asset returns of a negative 13.6%, much better than the overall market, and a remarkable performance considering the difficult market environment.

The team drove this result to be an effective hedging strategy on both the interest rate and equity fronts.

From an earnings standpoint, we expect a 7% -- $0.07 per share headwind from pension and post-retirement benefit expense in 2009 versus 2008.

The changes in funded status of our plan significantly impacted several lines of our balance sheet at year end.

These adjustments resulted in a decrease to stockholders equity of $2.3 billion.

For further details please refer to note J in the attachment to today's press release.

Looking ahead, our return on asset assumption for the US plan remained unchanged at 8.5% while the discount rate increased 14 basis points from 2008 to 6.14%.

For 2009, we estimate that we'll inject additional cash into the worldwide plans in the range of $600 million to $850 million, versus the $400 million that we did in 2008.

Now let's examine the fourth quarter performance for each of our segments, beginning with our largest segment, industrial and transportation.

Industrial and transportation has been among those most affected by the economy, particularly in big industries such as automotive and electronics.

Sales for the quarter were $1.7 billion, an 11.3% decline versus 2007.

Local currency sales were down 6.3% including a positive 3.2% impact from acquisitions.

Operating income declined 33% to $239 million with margins dipping to 14.3% for the quarter.

Full-year sales looked far more positive with sales up 7.6% to $7.8 billion and operating profit likewise increased 2.4% to $1.5 billion.

Strong operational discipline was the key to protecting the bottom line as full year operating margins held relatively steady at just under 20%.

Businesses that are heavily linked to automotive manufacturing, namely our auto OEM and Dyneon saw local currency declines of 20%-plus in the quarter.

As did businesses selling to the electronics industry, such as high-tech tapes and adhesives.

Most other areas experienced single-digit contractions.

A bright spot in the quarter was our automotive after market business which drove solid double-digit local currency growth, largely driven by the recent acquisition of McGuires and Bondo.

These are two outstanding brands in the professional body shop trade and a perfect fit for 3M.

Geographically speaking, Q4 local currency sales were down in all regions and the largest declines in the US and Asia-Pacific followed by Europe.

Local currency sales were about flat in Latin America.

I'd characterized 2008 as a tale of two distinct chapters for industrial transportation.

The first was January through October, characterized by outstanding top and bottom line growth across most of the portfolio.

The second chapter was the combined months of November and December, where by and large our customers brought their operations to a screeching halt.

We have effectively reinvented the segment over a number of years.

We expect the strength of our new products, supply chain improvements and expansion into areas like energy, aerospace, filtration and now renewable energy will help to carry us through some challenging times.

Now please turn to slide 11.

Health care completed an outstanding 2008 with an impressive fourth quarter.

Sales topped $1 billion in the quarter despite a nearly seven-point penalty from currency.

In local currency terms sales rose an impressive 4.5% including 2.2% from acquisitions.

Likewise, margins increased nearly 2% to 28.9%, the highest in the company as profits improved 4.5% to $298 million.

Our health care team pulled this off in a highly competitive environment where the 3M brand and quality is clearly making a difference.

Doctors, and hospitals and other medical service providers continue to show a strong preference for our products.

During the quarter, we saw solid growth in the medical products area, specifically in our core infection prevention and skin and wound products.

To build for the future, we also entered into new licensing agreements within our drug delivery systems business, which expanded 3M's extensive inhalation technology platforms for many partners in the pharmaceutical and biotech industries.

Looking geographically, the US and Asia-Pacific led sales growth and Latin America -- with Latin America showing remarkable operational discipline to drive a double-digit increase in operating income.

For the full year health care's results were outstanding with sales increasing 8.2% to $4.3 billion, and profits up 13% year-over-year to $1.2 billion.

Operating income margins came in at 28.7%.

Local currency sales were up 6.8%, largely organic, but also including 1.7% from acquisitions.

In 2008 we closed a number of important bolt-on acquisitions in health care, including TOP-Service, the German orthodontic technology and services company, offering digital, lingual solutions.

mTECH, an Oklahoma based manufacturer of dental implants, and cone beam computerized tomography, excuse me, and Solumed, a Quebec-based developer and marketer of leading-edge medical products designed to prevent infections in operating rooms and hospitals.

Full-year sales were led by double-digit increases in our medical, dental and orthodontics businesses.

Sales grew in all geographies led by double-digit gains in Asia-Pacific and in Latin America.

Please turn to slide 12 for a recap of our safety, security and protection services segment.

Sales in this business rose 2.9% in the fourth quarter to $769 million.

Local currency sales increased by 13% driven by the 2008 acquisition of Aearo Technologies.

Aearo contributed approximately 16 points of growth in the quarter.

The more we know about this acquisition, the more we like it, as Aearo has proven to be a great fit with 3M.

If you're not familiar, for decades we held a global leadership position in respiratory protection, but had only forged a small position in hearing protection.

Aearo is the global leader in hearing protection, so their synergies are obvious.

On a geographic basis sales for the quarter were strongest in the US followed by the Asia-Pacific region.

Operating income for the quarter declined 3.5% and margins dipped about 1 point to 16.7%.

Full year sales increased 19%.

In local currency terms sales rose 18% comprised of 14 points from acquisitions and 2 points each from organic and selling-price increases.

Divestitures were a two-point drag on year-to-date sales.

Worldwide operating income was up 21% to $774 million, and margins increased 40 basis points to a robust 21.3%.

Now please turn to slide 13 for details covering our consumer and office business.

Sales declined 11.2% to $765 million in the fourth quarter.

Local currency sales were down 6.5% and currency impact hurt sales by [descending] five points.

Over half of our sales in consumer office are generated in the United States, so let's start there.

In our US business sales declined about 13%.

By far the biggest contributor to this decline was the retail and wholesale office channel as the combination of massive office worker layoffs and declines in store traffic have significantly impacted sales.

Our businesses serve other US retail channels performed well in the fourth quarter despite this rough economic environment.

Sales of home care products such as Scotch-Brite and scrubbers were about flat in the quarter and sales to the do it yourself retail channel were down by low single-digits.

Elsewhere around the globe our consumer office business drove positive local currency sales growth in both Latin America and Asia-Pacific, but overall growth is muted by declines in Europe.

Worldwide operating profits declined 24% with operating profit margins of 15.5%.

For the full year sales grew just over 1%.

Operating income declined 1.5% and margins were just shy of 20%, outstanding results all things considered.

This business has done a fabulous job of creating new products and designing new programs and planograms for the large US customers in order to mitigate what is a very tough end market situation.

Please turn to slide 14.

Fourth quarter sales in display and graphics were $685 million.

Sales declined 28% or about 8% excluding optical, which most of you know is in the midst of a transition from a hypergrowth business a few years ago to one that is more commoditized in nature.

Optical film demand declined in November and December as most manufacturers and retailers throttled back hard on orders.

This rapid end market contraction and inventory reduction in portions of the channel drove sales declines in optical systems to 48%, not unlike many other suppliers that sell into this industry.

Traffic safety systems posted fourth quarter local currency sales growth of nearly 3% including 2.3% from the fourth quarter acquisition of a finished license plate provider in France.

This acquisition broadens our vehicle registration solutions offering beyond reflective sheeting to finished license plates.

And finally the commercial graphics business experienced mid-single digit local currency declines as median advertising budgets have been cut across the globe.

Operating margins and displaying graphics were over 10% for the quarter.

For the full year, sales in this business declined 16.6% and profits dropped 44% to $622 million.

Operating margins were over 19% for the year.

We have taken aggressive action throughout 2008 to reduce our cost structure throughout displaying graphics with particular focus on our optical systems business.

We expect these actions to generate 2009 cost savings of $45 million.

On the new product front, 3M's MProbe, an ultra-compact, LED-based projection engine for business and entertainment use continue to gain sales momentum from recent national media attention, including "Popular Science," MSNBC, Fox and national public radio.

The next generation engine, MM200 debuted at the consumer electronics show in January of this year and will be available for sale this year.

And in LCD monitors we continue to champion the energy savings story with our high performance films.

We're making good progress but we're still in early stages.

Finally please turn to slide 15 for an overview of results for electro and communications business.

The most important message here is that the important markets served by this business are consumer electronics and telecommunications along with a global power utility industry.

The weak holiday season experienced by consumer electronics retailers had a huge impact on our sales.

Likewise our telecom customers continue to cut back on new capacity and upgrades of existing equipment.

We in fact had a large number of equipment orders cancelled during the fourth quarter.

As a result of this end market contraction, sales of electro communications declined by 15% in the fourth quarter.

Sales in local currency decreased about 12% and currency impact hurt sales by about 3%.

Profits declined almost 31% and margins were 14.5%.

On a more positive note we celebrated another win in our electrical markets business as we sold another installation of our aluminum composite conductor to an energy service provider in Brazil.

So things continue to progress for this new 3M solution in the electrical transmission space.

For 2008 we increased both sales and profits in electro communications by about 1% to $2.8 billion and $538 million respectively.

Operating margins held steady versus 2007 levels at 19.3%.

That concludes my formal comments, so now I'll turn the program back over to George.

George?

Thank you very much, Pat.

Let me answer the question I posed earlier, which was, how long and deep will the recession be and what are the implications to 3M?

It would be very easy for me right now to evade the question of what's going to happen in the economy and hide behind the curtain of uncertainty and volatility.

But I'm not going to do that because I don't think it's helpful.

While I'll try to stay out of the business of being an economist, I think I have an obligation to give you the best forward-looking view I can at this time, balancing all of the factors that we know about today.

Please recognize this is a forward view and not everything is known.

If we believe the economy is deterministic, in the absence of clear visibility from the more complex econometric models that we're all familiar with, a simple cyclic analysis reveals quite a lot about what is happening.

The answers it gives may not be precise, but we think it can bring a directionally correct answer for our planning purposes.

In interest of time I'll pass over the details of how and give you the 30,000-foot level answers.

The analysis suggests that the US economy will continue to contract through the end of the second quarter of 2009 possibly marginally later.

If our methodology holds true we'll see sequential quarter on quarter economic growth in the third quarter of 2009 onwards, with the US returning to year-over-year growth at the end of the fourth quarter.

So how will this summary economic picture affect 3M?

The models we're using predicts a worse economy, worse global economy in the first quarter of '09 than the fourth of '08.

It suggests underlying organic sales volume will be lower in the first quarter than in the fourth quarter for two reasons.

The first and simplest reason is that we had only two months of weak sales in Q4, while we expect a full three in Q1.

Second, the continued softening of the economy, if correct, will cause organic volumes to be at slightly worse position than they were in the fourth quarter of 2008.

On this basis we need to recognize that the first quarter is probably going to be the toughest one of this recession for 3M.

I hope I'm wrong, but we're approaching the costs, the forecasting and the control elements of our business with this assumption in mind.

Moving on, end markets in the second quarter should be slightly weaker than the first quarter, but even in line for this, 3M sales should recover a little in Q2 as the inventory correction transients begin to bleed off.

This presumes that we have a channel that can work reasonably efficiently to clear the excess inventory and one which acts rationally in the face of any unknowns.

The third quarter should finally produce sequential quarter-over-quarter economic growth and gathering momentum into the fourth.

At the end of the fourth quarter or so, the US economy should return to positive year-over-year growth.

The fourth quarter for us will also see the benefit of easier year-over-year comparisons on both volume and on currency.

But overall deleveraging will pull down somewhat more than sales during the year.

So for 2009 total the summary effects of the economics produces growth rates in the middle of our [analysts] range.

So to reiterate, we're planning that organic volumes will decline in the range of 5% to 9% for the year, this is a couple of points below what we signaled in December and the difference is largely attributable to the dramatic decline in electronics and weaker-than-expected business conditions in both Latin America and Asia generally.

These volume levels place EPS in the band $4.30 to $4.70, down about $0.20 from our estimates in early December and in line with current consensus.

Please know that we are working hard to ensure that 3M will emerge a much stronger company and after the rebuilding of our core the past three years we are taking market share in almost every area.

Paraphrasing George Bernard Shaw, the best way to predict the future is to create it.

And toward that end, as Pat outlined, we'll continue to invest significantly in R&D.

Innovation has always been our not so secret competitive deadly weapon and nothing has changed there.

We think it's even more important in these times to differentiate ourselves from the competition through great products and great service, and we expect to earn new business as customers turn to proven suppliers with a demonstrated capability to deliver in good times and in bad.

It also provides the launch platform for growth as the economy recovers.

We will of course prioritize our R&D and other investments properly, and we will emerge from the downturn a leaner and more powerful company.

Overall I'm very optimistic about our prospects of sustained success.

The story of our company is not only about Q1 or even about 2009, we significantly strengthened our company strategically in 2008, and we intend to continue that directionally in 2009 and well beyond.

Planning conservatively, taking decisive action and driving innovation around the world continues to be our mantra.

So with those remarks, I'd like to turn the call over to you for any questions that you might have.

Thanks you very much for listening, everyone.

(Operator Instructions) Please limit your participation to one question and one follow up.

We'll pause for just a moment to compile the Q&A roster.

Our first question comes from the line of Scott Davis with Morgan Stanley.

Hi, good morning, everyone.

Good morning, Scott.

Guys, D&G margins were obviously weak and you addressed it in your commentary.

Rather than kind of looking backwards, maybe it makes some sense to talk a little bit about the end game of that business and how you are seeing it playing out in 2009.

I believe in your last investor meeting it felt like you were close to bottoming out there on the profit side, but clearly things got worse.

Is this business something -- are there certain components of this business that it's better off that in the long term you just exit and write off the investment, or is it something where you need -- you just need some more time to work its way out?

Thanks, Scott, for the question.

And I think it is a very interesting question.

You can imagine it's one that we thought about inside our company quite a lot.

If you separate TVs from the balance of the other segments, of the four segments, take out TVs, that was the one that did the worst in the fourth quarter.

And by the way, every part of that business is holding share, so that is a piece of good news.

Clearly what was going on in the economy obviously affected those guys you saw.

You saw what happened to some of our competitors, some of our contemporaries, some of the suppliers, how their results were just equally reflective of the ones we saw, too.

We're just part of that same puzzle.

So I think that our conclusions that this has, absent the fourth quarter, Scott, absent sort of this aberration, shall we say in the fourth quarter, of course nobody can't guarantee it won't run over into the first, but absent that aberration, I think the value proposition is still strong.

This is a business that ends up around $1 billion, or thereabouts, lower margins clearly than it was in the past.

And the difficulty has always been, Scott, when we thought about how do you separate one of these businesses, is one of the challenges, really, is the structure of 3M where everything is integrated, plants are shared, lines are shared, technology is shared, patents are used in one place and used in another.

Very challenging to figure out how to peel a piece off if you so wished.

So for the moment I think the best thing for us to do is to continue as we're going.

We are doing extraordinarily well, Scott, oddly enough, in capturing business now, which is energy-driven.

So instead of the old days where our films were used for brightness enhancement, they're now used to dim the brightness a little bit, and take out bulbs and reduce energy costs.

So that does seem to be gathering momentum.

Now I think what we're going to have to do is wait here until this current economic malaise passes and then make an assessment as to whether that strategy continues to be an executable one and make a final decision on what is best to do.

Okay.

And as a follow-up, different follow-up, of course, but talk a little bit about the M&A environment of your plans.

You stopped buying back stock, and that is understandable.

But you have a AA rating that you arguably have the best balance sheet in industrials right now.

How do you really, how do you think about the environment for M&A in '08 and '09, and how you can capitalize on others' weaknesses, that maybe weaker competitors or peers have?

I'll offer a comment and then I'll let Pat chip in if he wants on the end of it, Scott.

I think generally speaking the observations you make are correct.

There ought to be finally some opportunities coming up.

We are seeing pricing going down.

People becoming more realistic about pricing.

Of course, getting their signature on the seller purchase agreements is another matter, but nevertheless we are seeing some of that kind of stuff.

Pat and I took the decision to call acquisitions in the United States simply as a means of preserving cash here.

We have been less minded to do that overseas.

So we will probably continue to do some overseas.

I think that we'll sort of lay in the weeds and wait for some good opportunities.

Obviously we're studying many people, you can imagine, trying to make sure we're properly prepared.

Because you know how these things have been going.

It is the call that comes on Friday and the acquisition is agreed by Sunday.

So you have to be prepared and you have to be prepared to move swiftly.

So I think that we will keep our powder dry on that subject.

We certainly are not going to go out and waste any money.

But I do think from what I'm seeing there are some decent opportunities that might come up, and assuming we can finance it without in any way injuring our company, we will certainly take a long and hard look at that.

So it is not off the table, Scott, but we will be selective in what we do.

Scott, Pat here, we are very mindful that we are kind of in a premier class of the industrial companies and we do plan to stay there.

So, obviously, we are much more of a buy at our price, okay, and it will be at our terms, not necessarily what the seller wants and all of that.

So from that standpoint, we are doing everything we need to from a cash management standpoint to ensure that we remain a very premium grade credit.

Got you.

Thank you, guys.

Thanks.

Our next question comes from the line of David Begleiter with Deutsche Bank.

Good morning.

George, on health care, can health care be up next year, in either sales or profits, and how much of health care is either discretionary or in your view economically sensitive?

I don't think there is any real reason to believe that it can't, David.

The stuff that supplies the operating theater, the vast majority of that is happenstance.

It will be what it will be.

I'm only teasing you here, David.

You are not going to decide when you get appendicitis or not.

So forgive me there for teasing you a little bit, David.

But I understand where you're going in the dental business.

There are clearly some procedures which are discretionary, whether that is orthodontics or even getting a new crown may well be discretionary at some level.

So I think that the principal core of the medical business is going to be fine, HIS for example is still growing, very strongly, the health information systems business is growing very well.

As Pat outlined, the vast majority of our health care business was also doing quite well.

So I think the only unknown is, and it is an unknown, David, it doesn't mean I'm trying to avoid answering your question, the only unknown out there is how will people respond to the discretionary portion of dental.

I will though just remind you that we continue to innovate some absolutely fabulous stuff on digital dentistry.

Some wonderful acquisitions and new technologies out there on lingual care.

Real breakthrough ideas that are coming.

And in the end, some people will buy that stuff because it is more effective, not just because it is new technology, but because it is more effective in treating certain conditions.

So I think that we have to put up a probable question mark alongside dental, but on the balance of the business, probably being pretty optimistic.

Would you agree, Pat?

Yes.

I would agree.

I guess, Dave, dental probably is the one that is probably most exposed to some level of discretionary activity.

Our drug delivery business is a little bit lumpy at times, but on a long-term basis is a very solid business.

'09 is probably will be a little more difficult year for them relative to some of their contracts, and so forth.

But as I look at health care, and look at it against maybe some other industrials, health care being just under say 20% of the portfolio, and if health care can remain flat and actually they have got some acquisitions that ought to add some growth next year that's good -- that is worth a good maybe two points or so of growth rate for us on a composite basis.

So we feel very good about the health care business.

And, George, that is helpful.

Just on China, can you give us your perspective on just how bad China is overall?

It is a question of [bag].

Our sales in the fourth quarter, David, were about flat with last year, so this is not -- there is not any kind of cataclysmic problem in China, but clearly they've cooled, and they reflect the balance of the world economy, they supply to the world economy, and I think there will probably be a move in China.

China has a lot of infrastructure programs it wants to get completed.

I suspect given the economic power of China, that will go forward.

That is certainly all the indications we're receiving.

So I think China probably after a dip in the fourth and maybe the first probably begins to come back a little bit.

Maybe to growth rates at half or two-thirds of what they were before, reflecting what is going on in the world economy.

That would be my guess.

I think China is going to be okay, David.

We've got huge penetration opportunities in China.

Huge, with many of the businesses that we are.

So we have decided that we are going to advance some investments in China to make sure where these growth opportunities exist, to the extent we can do it prudently, we are going try to to take advantage of those opportunities.

Thank you.

Our next question comes from line of Shannon O'Callaghan with Barclay's Capital.

Good morning.

Good morning, Shannon.

Hey, couple of margin questions.

In terms of the assumption, are you guys still looking for flat margins year over year, and if so, can you give us kind of a walk of how we get there from here?

Shannon, it's not too dissimilar from what we presented in December.

Now, as George outlined, we've kind of slid the volume curve over by about two points, and if I recall the comments I made in December was, at about a 5% volume decline, we thought we could hold -- be relatively close to holding margins.

As you slide a little more to 7% to 9% it becomes a little more difficult to do that on the margin.

So I would say at the upper end of the volume range our margins probably hold reasonably close, but then you probably slide them a little bit.

On the bottom end we may have a point of risk off of '08 levels.

So I guess one of the things that change then relative to this quarter, I mean, organically you were down kind of at the high end of what you were looking for in '09 and we had 310 basis points of contraction.

What was --

I think you have to be a little cautious, Shannon.

When you have an abrupt change, okay, in volumes, your margins aren't going to perform as well as on a more steady state basis.

There is no doubt that Q4, as George outlined, Q1 will at least as we see it today will be by far the most difficult quarter we have both probably top and bottom line, and then as we work through the inventory correction, and as manufacturers regain production and so forth, later in the year, we will see the recovery, is the way that we would see it.

So Q4 margins obviously were under pressure.

Q1 you'll see a very similar trait, and then through the back end of 2009 you will see a recovery.

Okay.

And just kind of a follow-up to that.

I mean, George, you mentioned talking about optical, kind of an aberration in 4Q, which ended in more extreme ways getting to what Pat is talking about with sharp corrections, impacting margins unusually strongly.

What do you mean by aberration?

What do we think about for the normal margins of that business?

I mean, you said it is not losing share anymore so it is mainly it is this sharp correction in the quarter.

What do you think is normal for that now?

Well, I think obviously, Shannon, it is going to be an interesting question as to how long this particular starvation diet that electronic people are on lasts.

It certainly is going to last, I think, through this quarter, it may last a little longer.

But if I take that out, Shannon, and think about where this business is going to go in stasis, I think this business is -- there is nothing I know that will convince me yet or suggested to me yet that this is anything other than about a $1 billion business in late teen margins of that order.

Now, at this continued decline and this continued commoditization, Shannon, those margins may come under pressure, but I think that's the sort of range.

If you can look past the next quarter and even the next two quarters as they recover, and some of the volume in the energy areas begins to pick back up, again, then I think it's probably going to settle down in that range.

Do you have any other opinion, Pat?

No, I think that would be a fair read.

Thanks a lot.

Our next question comes from the line of John McNulty with Credit Suisse.

Yes, good morning.

Good morning, John.

George, at the beginning you talked about how you've seen the inventories or inventory reductions pretty dramatically across all of your customer base.

But you expect that at some point it gets overdone and you start to see a snap back.

Do you have any color based on conversations that you've had and what you've seen with some of your customers as to when that snap back actually might really come back?

I think the direct answer to your question is no.

Some of them are still working through these inventories, John.

But I think if you look at just the pure dynamics of the system, as I've mentioned, when I was making my remarks, in a wholly efficient correction process you would think about one inventory turn for the correction to take place.

So we're running four turns per year roughly speaking, you would think it would take a full quarter, but in reality there is no such thing as 100% position channel correction.

So I think this thing is going to run through all or most all of the first quarter.

I can't swear it won't even bleed over a little bit into the second.

But I think it is at that point, John, where you see the sort of settling down of the transients in the supply chain that would come back closer to what the real end market actually did.

Of course we are a very, very complex business, very, very extensive, different national, different markets, that are performing differently.

But when you put all that in the pot and stir it, I'm thinking that the vast majority of this gets finished by the end of the first quarter, maybe a little bleed into the second, and so it's at that point, John, that we probably get a better sighting shot of what the real end market run rates really are.

When all of that clutter and all of that confusion clears, and obviously we hope, and I expect also that we'll see significant recoveries in sales some time in the second quarter.

Okay.

Great.

And just as a quick follow-up, with regard to selling price, I know, Pat, you had indicated the 1.7% real price increase that you saw in the fourth quarter were some of the largest that you've seen in a number of quarters out there.

I'm wondering when you expect to see, or if you expect to see any push-back on the price given that the whole raw material environment's dropped down as well as clearly the economy is under a lot of pressure as well.

John, of course, you get pushed back.

I would say we've already seen it, okay?

And you would expect it.

What first of all in our plans, what we're thinking about is we don't really have price increases built into our '09 plans, if that's what we're thinking about, is how do we hold what we've already gone after reflecting our own cost inputs and so forth.

I think with the strength of our brands, the strength of our customer relationships in many cases, gives me more confidence, where we're positioned in the market, than if I was at much more the bottom end of the market.

But that doesn't mean that we won't have it.

We see it in our businesses all the time, and if we have to give back price, that means we have to go after more in the way of other kind of productivity programs, and so our businesses are managing that very, very closely.

I think there is one other point I would like to make, John.

If the environment is such that people can put pressure on us for price, the environment is such that we can put pressure on other people for price.

So I don't expect that the gap, the increment is going to alter much in terms of the overall margin of the company.

So I think you've got the fact that Pat mentioned about brand, the strength of our distribution channels, the wonderful reputation of our products, coupled with the fact that if we get pressured, we have clearly got an environment where we can pressure others.

So I don't expect the gap is going to alter our financials all that much, John.

Great, thanks for the color.

Thank you.

Our next question comes from the line of Mike Judd with Greenwich Consultant.

Hi.

Couple of quick things.

The tax rate for '09, do you have any guesstimate there?

Mike, we ended up the -- first of all, the '08 year, at 30.9% on a kind of exclude basis.

For our planning purposes for '08 -- for our planning purposes for '09, we assume this is going to be about a 31% range.

That doesn't mean we're giving up.

That is from a planning standpoint.

We'll keep working at it.

Okay.

And, fair enough, and I guess the book stockholders equity was down around 19% sequentially.

Yes.

And that no doubt due to some of the pension issues, right?

Right.

And if you could just kind of help us understand what that trend could look like, and there is also a significant amount of goodwill amortization on the balance sheet.

Is there a chance that some of that will be written down as we go over -- we go through the next year?

First of all, to answer your equity kind of question, in the press release we go through the biggest description, of course, was the change in the pension funded status, which I described in my comments, and I think is in a footnote J, I think, is the footnote.

I don't really -- if the pension markets remain relatively consistent over time, you won't see big movements.

As a matter of fact you ought to see equity continuing to grow as our earnings increase.

So a lot of it will -- is dependent upon what happens relative to some of our pension and post-retirement obligations; that is what will swing that around.

But I don't see that as being big movements necessarily going forward.

This was a very unusual period I think for that to kind of play out.

On goodwill, we look at our goodwill on a reported basis against all of our business units, on an ongoing basis from an impairment perspective, and I don't see anything.

We've completed our '08 assessments and there is nothing impaired.

Okay.

And I realize that the absolute level of pension expenses going up as it runs through the income statement, but are you anticipating making any additional voluntary pension contributions?

As you are cutting back on CapEx and share repurchases, will you be putting additional cash into the pension?

Yes.

Mike, in one of the slides we show a number that, from a planning standpoint on a global basis, we have -- it was between maybe $600 million and $850 million that we notionally are planning now for '09.

We'll make those decisions as we go through the year.

So, yes, there is an increased pension.

Now, none of those are mandatory.

We're not in a situation where we are in any kind of a mandatory contribution in the US.

In some of our international plans we have little more, but those are much smaller in nature.

Fair enough.

Thank you.

Thank you.

Our next question comes from the line of [Steven Whitaker] with Sanford Bernstein.

Good morning.

Morning, Steven.

I have first a couple of questions in terms of the strategic programs that you've talked about in the last investor day.

The deferment of CapEx and all of the doing discretionary programs, what is the impact of that in supply chain changes?

Also on the R&D mix, so you're maintaining funding and increasing funding, but is there anything dramatic in terms of shifting R&D to product cost redesigns for '09 versus the longer-term programs?

And then the down-market strategy, are you accelerating the lower price century programs as well?

Thanks, Steve.

Let me have a crack at that question and Pat can chip in if he wants.

The supply chain restructuring, Steve, had three elements.

It had an element that was concerned with placing capacity close to customers and -- as a means of shortening the supply chain and in some cases as a byproduct of that improving the tax rates.

There was a parallel activity which was mostly in the United States, but not only in the United States, that was dedicated to what we called unpicking the hairball.

In other words, it was one supply chain's multiple hops that went through a range of existing plans all of which were going to remain open.

So that program we would be trying to cut seven hops down to five and three hops down to one, that kind of stuff.

And then lastly the third program here was the building of these super-hubs that were in place where we could take advantage of great customer service, low cost and low taxes, all in one location.

So the three things were running in parallel.

The first of those, the addition of capacity in places where we needed it.

That is the program really that we've deferred at the moment, because we don't need the capacity.

Of course it does slide our supply chain restructuring program a little bit to the right, but it is nevertheless the right thing to do.

We will, however, still spend money on unpicking the hairball, as we call it, trying to take the seven stops to three, the three stops to one, the four stops to two and so on and so forth, and in a limited number of cases we will invest in the -- in those super-hubs, the third piece of the puzzle.

And that is what has really brought our ability to drive the number down to where we are today.

There's been little big change, Steve, in moving off longer-term programs to short-term programs.

Almost by the time we would get such a thing mobilized and and it would deliver effect, hopefully the economy will have recovered to the point where it is not needed anyway.

So there is not very much of that going on.

What is, however, going on, is quite a bit of insourcing, Steve, where we are using some of our scientists to requalify materials, where we can do it inside, or we can resource it to a second vendor at lower cost.

It is all part and parcel of the sort of shall we say the inherent strengthening of the company.

Those sorts of things are happening.

But there's no real material policy change in our reports to R&D that might cause you concern for the long term.

Okay.

And on the strategy and moving down market, in products?

It seems to have worked in the places where we have done it.

Steve, it seems to have worked absolutely brilliantly.

I'll give you one or two quick examples.

I think if you were there at our last investor meeting, we actually talked about a couple of them.

One was in our air filters.

I'll try to make this story short.

We used to have the air filters, the Filtrete filters just in the top of the market.

I kind of was under the impression it was a relatively new product.

It turns out we had that stuff in the market for about eight years.

It was limited distribution in True Value Hardware stores and Ace and places like that and was sort of a specialist product, very high performing and relatively expensive.

When we invented product that was suitable for the middle of the market all of a sudden that opened the doors of getting mass distribution in the mass channel with the big retailers, the big ones that you know about.

And in fact what actually happened there, Steve, is we got growth in the middle and the top simultaneously, and we're actually working on things that will try to fill in the bottom now.

And I can tell you a parallel story to that in a number of different businesses in a number of different parts of the world, it seems to be working very, very well.

And as long as we're careful about making sure we get growth in the top of the market, Steve, and we make sure that we properly use secondary brands and in some cases private labeling, it seems to be working extraordinarily well.

It doesn't seem to be damaging margins, it seems actually to be getting us more share, making us more influential with our customers, and overall driving our factory absorption.

Great.

Thank you.

And one quick follow-up.

If I compare just looking at history, the last recessions, as difficult -- as different as they were, even in '93 when you had volume or revenue down, I don't know about 20% and EBITDA down about 10% in '01, revenue and EBITDA down 4%.

What do you -- what are you doing differently this time where the experiences in much worse situation?

How do you see this 3M different now than in history?

Yes, Steve, Pat here.

This is probably a little difficult for either George or I, because neither one of us were here.

Okay?

Yes.

But if you look at kind of what we're doing, George kind of outlined a number of actions we're doing, I think the company is far different than it was in the most recent downturn post-9/11.

The strength of the portfolio, the company across our businesses are a lot stronger.

Coming out of 2001 and 2002, we only really had a couple of businesses that we were counting on for growth, and the reality is that we're really counting on the broader portfolio to get us there.

And on the cost side we continue to work on all of the avenues.

George outlined a couple of things we're doing on a more temporary basis around freezing pay, some of our vacation accrual plans and so forth.

So we effectively get to a near -- an acceptable near-term performance, but also make sure that we ensure that we keep investing in those things that are going to make us successful once the economy recovers.

So I think we're doing the right kind of things.

I'm very thankful for the margin structure that we have going into a recession.

It gives us degrees of freedom that I think that others may not have.

So I feel very good about where we're positioned.

Thank you.

Okay.

That concludes the question and answer portion of our conference.

At this time we'll turn the call back over to 3M for some closing comments.

I would like to thank everybody for joining us this morning.

We look forward to talking to you or speaking in person very soon.

So, have a great day.

Thank you very much.

Ladies and gentlemen, that does conclude our conference for today.

You may all disconnect and thank you for participating.